fed: If You Were Responsible For The Biggest Bust Since FDR, Would You Take The Blame?

U.S. mortgage rates’ linkage to short-term U.S. rates had been close for decades. Between 1971 and 2002, the fed-funds rate and the mortgage rate moved in lockstep. The correlation between them was a tight 0.85. Between 2002 and 2005, however, the correlation diminished to insignificance.

.. the presumptive cause of the world-wide decline in long-term rates was the tectonic shift in the early 1990s by much of the developing world from heavy emphasis on central planning to increasingly dynamic, export-led market competition. The result was a surge in growth in China and a large number of other emerging market economies that led to an excess of global intended savings relative to intended capital investment. That ex ante excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005.

That decline in long-term interest rates across a wide spectrum of countries statistically explains, and is the most likely major cause of, real-estate capitalization rates that declined and converged across the globe, resulting in the global housing price bubble .. By 2006, long-term interest rates and the home mortgage rates driven by them, for all developed and the main developing economies, had declined to single digits — I believe for the first time ever. I would have thought that the weight of such evidence would lead to wide support for this as a global explanation of the current crisis.

Another interpretation for the decorrelation of the short and long rates that Greenspan cites as evidence of a savings glut: “Does the absence of inflation since the turn of the century show that the Fed has smartly kept the interest rate in the near neighbourhood of the “natural rate”? Obviously not. More than a dozen quarter-point hikes of the short rate to which the markets paid basically no attention (the long rate not reacting) mean instead that the Bank had engaged in such an extraordinarily expansionary policy that it had lost all contact with the markets.”, from “The perils of inflation targeting” by Axel Leijonhufvud.